The Fed Continues With QT, and Winds Down Emergency Measures

The following analysis breaks down the Fed balance sheet in detail. It shows different parts of the balance sheet and how those amounts have changed. It also shows historical interest rate trends.

Breaking Down the Balance Sheet

Back in May 2024, the Fed announced a reduction in QT from $95B to $60B. The data shows that this was moving forward as expected, mostly coming in under the target amount. In November, there was a big run-off and since then the Fed has allowed $19B, $68B and $52B to roll off the balance sheet. All combined, the run-off over the last 4 months has averaged about the $60B target.

Figure: 1 Monthly Change by Instrument

The table below provides more detail on the Fed’s QT efforts.

Figure: 2 Balance Sheet Breakdown

The weekly activity can be seen below. As shown, it’s been mostly consistent with big chunks along the way. It is also allowing a range of maturities and products to roll off.

Figure: 3 Fed Balance Sheet Weekly Changes

The chart below shows the balance on detailed items in Loans and also Repos. These were the programs set up in the wake of the SVB collapse early last year. All of the programs have dropped down to zero at this point showing that the emergency measures have come to a close.

Figure: 4 Loan Details

Yields

Yields have been fluctuating within a band since Sept 2022, ranging mostly between 3.25% and 4.75%.

Figure: 5 Interest Rates Across Maturities

The spread between the 2 year and 10 year has finally turned positive. When the inverted yield curve predicts recession, the recession does not usually occur until sometime after the spread turns positive. This ranges between 6 and 18 months. Considering we are hitting the 6 month point now, this could be a bad sign for the months ahead.

Figure: 6 Tracking Yield Curve Inversion

The chart below shows the current yield curve, the yield curve one month ago, and one year ago. It is clear to see the short-end coming down while the long-end has remained mostly flat.

Figure: 7 Tracking Yield Curve Inversion

The Fed Takes Losses

When the Fed makes money, it sends it back to the Treasury. This has netted the Treasury close to $100B a year. This can be seen below.

Figure: 8 Fed Payments to Treasury

You may notice in the chart above that 2023 and 2024 are showing $0. That’s because the Fed has been losing money. According to the Fed: The Federal Reserve Banks remit residual net earnings to the U.S. Treasury after providing for the costs of operations… Positive amounts represent the estimated weekly remittances due to U.S. Treasury. Negative amounts represent the cumulative deferred asset position … deferred asset is the amount of net earnings that the Federal Reserve Banks need to realize before remittances to the U.S. Treasury resume.

Basically, when the Fed makes money, it gives it to the Treasury. When it loses money, it keeps a negative balance by printing the difference. That negative balance has just exceeded $224B! This negative balance is increasing by about $10B a month!

Figure: 9 Remittances or Negative Balance

Who Will Fill the Gap?

The Fed has not been buying in the Treasury market for over a year (they have been selling); however, the Treasury is still issuing tons of new debt. Who has been picking up the slack since the Fed stepped away?

International holdings have increased a decent amount over the last year by over $400B. Unfortunately, this pales in comparison to the amount of debt issued by the Treasury overall which is closer to $2T.

Note: data is updated on a lag. The latest data is as of December

Figure: 10 International Holders

It should be noted that China continues to reduce holdings of US Treasuries. They have dropped $500B over the last decade, while Japan has been mostly flat over the same time. The slack has been picked up by other countries.

Figure: 11 Average Weekly Change in the Balance Sheet

Historical Perspective

The final plot below takes a larger view of the balance sheet. It is clear to see how the usage of the balance sheet has changed since the Global Financial Crisis.

Figure: 12 Historical Fed Balance Sheet